The Koch method for oil measurement followed a few simple steps. First, Dubose dropped his gauge line to see how deep the oil was. If the gauge line said it was fifteen feet and two inches, Dubose would record it as fifteen feet and one inch. Already, this meant that Dubose was getting an inch worth of oil for free. This was called “cutting the top.”
Then he measured the “gravity” of the oil, which determined its quality. The top-dollar crude oil fell within an API measurement of gravity between 40.0 and 44.9, so Dubose fudged the numbers to push it outside of that range. This way, Koch would pay the oil producer less for the oil, even if the quality was ideal. If the oil measured 40.0, then he would record it as 39.2, for example.
After Dubose drained the tank, he would take his final depth measurement, which was recorded to show how much oil Koch had taken. If Dubose measured that fourteen inches of oil were left, he would record it as fifteen inches. This meant he was paying for one less inch of oil than he had taken. This technique was called “bumping the bottom.”
Dubose learned the Koch method by rote. He estimated that by using it, he could get about ten to twelve extra barrels of crude from each tank he drained. That was only a small fraction of the whole, but it was enough to ensure that he was over at the end of every month. And he knew that the extra oil added up over time, because all of his coworkers were doing the same thing.
Dubose’s bosses measured the amount of oil that Dubose drained from each tank, and then they compared it against the amount of oil he finally delivered into Koch’s pipelines or terminals. Everybody knew that those numbers probably wouldn’t match up exactly, thanks to the slippery nature of oil. If a gauger was under, it meant that he delivered less oil into Koch’s pipelines or trucks than he gathered. If a gauger was over, on the other hand, then the opposite was true: he’d delivered more oil into Koch’s system than he had recorded gathering at the oil tanks. It was only possible to be over by mismeasurement because it was physically impossible for oil supplies to increase as they made their way through the supply chain.
At the end of each month, Koch tabulated its oil shipments and figured out if each was over or under. The company posted the results at the branch office where Dubose worked. If a gauger was consistently under, his manager would grill him and ask what was going wrong. If a gauger was consistently over, then he had no problems.
Dubose’s boss at the time was a manager named Doyle Barnett, who later recalled the reason for encouraging employees to be over. “You wanted to keep your company operating for sure. So, I guess I’d rather be over than short if I was the company,” Barnett said. His bias toward being over was widely shared by Koch managers across the country. Keith Langhofer, a Koch Oil manager overseeing Texas and New Mexico, would later tell federal investigators that he also encouraged his gaugers to be over.
“I think we probably take an aggressive approach to purchasing crude oil. We certainly don’t want to be short,” Langhofer said, while under oath. If an employee came up short, then he was punished or demoted. If an employee was consistently over, the company “didn’t do anything to him,” Langhofer said.
It was clear to Dubose that the Koch method was not the industry norm. New hires expressed shock at the company’s practices. In fact, the norm was for oil companies to be slightly under overall because it was more natural for them to lose some oil along the transportation chain rather than miraculously create oil, as Koch did. Even being slightly under, these other firms made money—oil was a profitable business, after all. The new hires at Koch either adapted, or they quit.
Dubose adapted. He knew in the back of his mind that he was effectively stealing oil. But it was only a little bit at a time. He took comfort in the fact that measuring oil was an inexact science. No one ever got it perfect.
“It’s a very gray area. And I think Koch saw this,” Dubose said. “They saw where they could manipulate this, because it’s such a gray area. And they took advantage of it.”
* * *
Koch’s oil gathering division delivered a steady flow of cash and profits into the company. This money gave Charles Koch a chance to put his management theories to the test. He encouraged his employees to look for new growth opportunities and to act like entrepreneurs. He wanted to lead by example. In his first years as head of Koch Industries, Charles Koch put together one of the most brilliant and profitable deals in the history of Koch Industries. The deal involved an oil refinery.
Since the late 1950s, Fred Koch had owned a minority share in the Great Northern oil refinery outside of Minneapolis, near the Pine Bend Bluffs natural reserve. The other shareholders in the refinery were an oil tycoon named J. Howard Marshall II and the Great Northern Oil Company. In 1969, the refinery didn’t look like a gold mine. Competition in the sector was fierce, with new refineries being put into production monthly.
But the Pine Bend refinery, as everyone called it, had a secret source of profits. And this source of profits could be traced to exactly the kind of government intervention that Hayek hated most. In the 1950s, President Dwight Eisenhower capped the amount of oil that could be imported into the United States, in one of the federal government’s many ploys to protect domestic oil drillers. (Imported oil was often cheaper than domestic oil, so US drillers wanted it kept out.) But there was a loophole in that law that allowed unlimited imports from Canada. As it happened, Canada was the primary source of oil processed at the Pine Bend refinery. Pine Bend was one of only four refineries in the nation that was able to buy cheaper imported oil in unlimited quantities, giving it a huge advantage over firms that were forced to buy mostly domestic oil. The four companies who benefited from this loophole received a second advantage from the government. Thanks to a complex voucher system for oil imports, companies like Koch were able to “double dip” and exchange their voucher tickets for domestic oil in a scheme that gave them a subsidy of $1.25 per barrel. This loophole boosted profits, and Fred Koch had been happy to remain a minority shareholder and enjoy the windfall.
In 1969, Charles Koch executed a secret plan that would increase those profits beyond anything Fred Koch could imagine. Charles approached J. Howard Marshall and convinced Marshall to sell his share in the refinery in exchange for shares in Charles Koch’s newly created firm, Koch Industries. When that secret deal closed, Charles Koch was a majority shareholder in the Pine Bend refinery. He then approached Great Northern, now a minority shareholder, and convinced that company to sell its ownership stake. By the end of the year, Koch Industries was the sole owner of the Pine Bend refinery. Charles Koch saw something in the refinery that others didn’t see.
There was, however, one significant obstacle standing in the path of Charles Koch’s plan. It was a labor union.
Workers at the Pine Bend refinery had been organized in a union since the 1950s. The union was deeply entrenched and powerful. No sooner had Charles Koch purchased the Pine Bend refinery than he learned that he could not control it. Charles Koch had almost total authority over Koch Industries, but his authority was hemmed in at the Pine Bend refinery. The union set the rules in Pine Bend, and the union set the wages. Over the years, the labor contracts in Pine Bend became so favorable to the employees that even some of the union members thought that it was a little excessive.